New Options for IRAs in 2010

Submitted By Tushar Mathur

Financial experts are buzzing about a change in rules to Roth and Traditional Individual Retirement Accounts (IRAs), so you might be wondering what it all means. To refresh your memory, Roth IRAs are taxed when your money goes in. Traditional IRAs are taxed as you take the money out.

From 2010 on, anyone with a Traditional IRA can convert it to a Roth – income limits no longer apply. Keep in mind that income limits still apply for Roth contributions, just not conversions. If you convert in 2010, you choose when to pay the taxes.

Here's what else you need to know before converting to a Roth IRA:

The Advantages

Earnings accumulate tax free starting from your conversion date.
You'll pay no taxes on withdrawals in retirement (so long as you're at least 59½ and had the account for 5 years or longer).
Converting in 2010 lets you choose when to pay tax on the conversion amount: all in the 2010 tax year or splitting income (and the tax amount) evenly between 2011 and 2012.

Possible disadvantages

You'll pay income tax on the conversion amount.
If you want to avoid withdrawal penalties, you'll need to pay the tax with funds from a non-IRA source.

Who should convert? Not everybody. It may make sense for people who:

Believe their tax rate at retirement will be the same or higher than now.
Know retirement is far off, and can pay the tax now from non-IRA sources.
Plan to leave the Roth IRA (tax free) to their heirs. Since Roths don't require distributions at age 70½, they can grow tax free until the heirs make withdrawals.

Now you've got the basics down. Next step? Analyze your situation with your tax advisor.